Powell is fine with a recession … assessing the damage already done … why we believe we’re in for one more leg down … the coming buying opportunity
The poet Maya Angelou once said “when people show you who they are, believe them.”All year long, Federal Reserve Chairman Jerome Powell has shown us who he is – someone dead-set on killing inflation regardless of the collateral damage.Wall Street has refused to believe him.The difference between Wall Street-expectation and Powell-reality has resulted in a series of hope-based rallies that have eventually failed all year long.
Today, the “collateral damage” we just referenced potentially includes a recession.Powell has already told us what he will do.Remember this gem from back in November when Powell explicitly said he prefers the error of over-tightening to the error of under-tightening:
The risks are asymmetric. If the Fed does too much, it can cut. If it doesn’t tighten enough, then you’re in real trouble…It is very premature to be thinking about pausing…We think we have a ways to go.
And if that wasn’t clear enough, here’s Powell from back in June:
Is there a risk we would go too far?Certainly, there’s a risk.The bigger mistake to make—let’s put it that way—would be to fail to restore price stability…
The market carnage we’ve seen since last Wednesday feels like Wall Street suddenly coming to the horrific conclusion of “Good Lord, he’s serious! He’s actually willing to crash the economy!”Last Friday, in his Special Market Podcast for his Platinum Growth Club subscribers, Louis Navellier reflected on the extent of the damage the Fed has already unleashed.From Louis:
Let’s just step back and look at what they’ve done.They’ve destroyed the manufacturing sector. It grew for 30 straights months – it’s underwater now. Things like new orders and backlogs, they’re all gone. So, manufacturing is in trouble.Some of that is related to the housing market. When housing sales slow, it slows sales for appliances and things like that. So, they’ve killed manufacturing and housing.And then, of course, [last Thursday] we had a very bad retail sales report. The only thing good in retail sales was that spending at bars and restaurants was up…Very disappointing retail sales in November, despite lots of Black Friday deals and that good stuff.So, it looks like the holiday shopping season isn’t going to be that good. Online sales are down everywhere. Clearly, consumers are prioritizing their spending.The truth of the matter is the Fed is doing a good job of pricking the economic bubble.
So, what happens if a “prick” turns into a full-blown recessionary “pop”?Well, it means two things:One, Main Street has significant pain in front of it…Two, Wall Street is finally approaching a fantastic buying opportunity.
Remember, the economy and the stock market don’t operate on the same timeframe
Wall Street tends to be forward-looking. It does its best to anticipate market conditions roughly six-to-12 months ahead and tries to position itself for that environment.It makes sense…If you believe Company A is going to make money hand-over fist, say, eight months from now, it would be reasonable to buy its stock today to benefit from the run-up in price as the market rewards Company A for earning more money.I’ve leaned bearish in recent months because as I’ve looked six-to-12 months forward, I’ve seen deteriorating economic conditions due to the lag time between the Fed’s interest rate hikes and when we feel the damage of those hikes in the economy.Here’s what I wrote about this in last Thursday’s Digest:
Remember, there’s a lag time of roughly six to eight months between a Fed rate hike and when the economy feels the sting of that rate hike.So, conditions today reflect the Fed’s hikes that took place before roughly April through June. We’ll split the difference and say “May” to make it easy. That means we’re feeling the effects of the March hike of 0.25% and the May hike of 0.50%.Now, consider the avalanche of rate hikes that have happened since then…June – 0.75%… July – 0.75%… September – 0.75%… November – 0.75%… December – 0.50%…That’s a tremendous amount of economic tightening baked into the cake that’s going to hit corporate earnings in 2023.
Analysts like me who lean bearish today don’t believe Wall Street has accurately priced this forward-looking economic weakness into corporate earnings forecasts…which means stock prices remain too high because they’re still based on rosier earnings forecasts.
But this brings us to a bullish hypothetical…
Let’s say that as we get into the new year, economic conditions continue to deteriorate.The analysts who make the official earnings forecasts are forced to lower their forecasts. Wall Street sees this and begrudgingly re-prices stocks accordingly.The repricing fuels bearish sentiments, which exacerbates the anxious selling by retail investors. So, we have a one-two-punch combo of reduced earnings estimates and crumbling sentiment.That would mean one final leg down for stocks either in either Q1 or possibly Q2.But at that point in our hypothetical, things will finally be quite different…One, stock prices will be lower than today, offering investors more reasonable entry-point valuations.Two, as we look six-to-12 months ahead from that point, it’s far more likely we’ll be looking at the other side of the rate-hike-induced economic pain.Sure, Main Street will have months of rough going ahead of it, but for Wall Street’s forward-looking timeline, the time will be right to price in the improved economic conditions that lie beyond the rough going.In other words, that will be our buying opportunity.
Historical market data help explain this relationship between a recession and a bear-market bottom
Earlier this year, we highlighted a report from Goldman Sachs suggesting that the low point in the stock market usually comes three to six months before the economy’s low-water mark.With most of the Fed’s rate hikes not yet absorbed into the economy, the low-water mark for Main Street remains in our future. It’s unclear how far but consider interest rate lag-time itself – estimated to be roughly six-to-eight months.Let’s assume the Fed finishes hiking rates in February. Add the lag-time of six-to eight months, and the low-point in the economy would be in the neighborhood of August to October (this is very crude for illustrative purposes).Now, back up three-to-six months based on Goldman’s research about stocks bottoming out before the economy. That puts us somewhere between February and July for when stocks will find their lows – if this hypothetical plays out, of course.But logically, it makes sense that if the Fed is willing to crash the economy… if much of the painful effects of 2022’s rate hikes remain in front of us… and if Wall Street has yet to accurately capture that pain in its earnings forecasts… then smoothing out these wrinkles requires one more leg down for stock prices.But at the bottom of that leg down will be a fantastic buying opportunity.The crude math we’ve done today suggests it’s most likely coming sometime in Q1 or Q2 of 2023.The variable we’re watching is how low that final leg down will take us. But history suggests that when things feel the worst, that’s when buying serves you the best.We’ll track it with you here in the Digest.Have a good evening,Jeff Remsburg
